Nation of Debt: Govt and Reserve Bank no longer rowing in the same direction

Reserve Bank Governor Adrian Orr and Finance Minister Grant Robertson in 2018. Photo / Mark Mitchell

ANALYSIS:

It would be remiss to write about government debt without mentioning the closeness of the Government and Reserve Bank of New Zealand (RBNZ) over the past few years.

While the two operate independently, they enjoyed a symbiotic relationship during 2020 and 2021.

Come 2022 and the Government and bank remain joined at the hip. But they're no longer rowing in the same direction.

As critics of the current amount of government borrowing argue, elevated levels of spending aren't doing anything to help dampen inflation.

But one could make the case that the RBNZ's actions aren't particularly helpful for the Government either.

In early 2020, the Government and the RBNZ had the same mission – provide an unprecedented amount of stimulus to support the economy.

The bank's ability to do so by cutting the official cash rate (OCR) was almost exhausted because the rate was already very low. So, it launched its Large-Scale Asset Purchase (LSAP) programme.

This saw it figuratively create money to buy $53 billion of New Zealand Government Bonds (government debt) from banks between March 2020 and July 2021.

The RBNZ's massive intervention in the bond market was aimed at putting downward pressure on long-term government bond yields, which affect interest rates more generally.

The programme enabled the Government to issue an unprecedented amount of debt to pay for the Covid-19 response, as it knew there was a buyer of last resort for all the bonds it was issuing.

The arrangement also suited the Government, as it lowered its debt servicing costs.

However, now that the RBNZ has started lifting the OCR to get on top of inflation, it has decided now is good time for it to get rid of all the bonds it bought via the LSAP programme.

It wants to remove stimulus from the economy and normalise the size of its balance sheet to make it easier for it to potentially use money printing again in some future downturn.

So, the RBNZ has just started the process of selling $5b of bonds directly back to the Treasury every year for five years. The Treasury will then retire the bonds.

The short-dated bonds the RBNZ owns will mature within this five-year period, so won't need to be sold.

The pinch is, the Treasury will need to borrow more than it otherwise would have to get the $25b required to buy the bonds from the RBNZ.

The situation sees the debt that was financed by easy printed money, replaced by debt financed by regular investors in New Zealand and abroad. It replaces the free lunch with a lunch that needs to be paid for.

Furthermore, while the Treasury credits the LSAP programme for stimulating the economy in 2020 and 2021 (to the benefit of the Government's tax take), the programme also came at a direct cost.

This is because the RBNZ bought the bonds at a high point in the market and is selling them at a low point.

The bonds were worth around $8.8b less than what the RBNZ bought them for, at the end of June. The value of this differential will fluctuate daily as interest rates change.

So, by the time the RBNZ sells all the bonds it bought via the LSAP programme, the loss could end up being higher or lower than $8.8b.

The Treasury is recapitalising the RBNZ to ensure the loss doesn't make it insolvent.

The takeout of the situation is: money printing didn't come for free.

The Treasury argues the programme benefited the economy. But it concluded that without a reliable estimate of its effects, "the total impact of the LSAP programme will remain unclear".

NATION OF DEBT SERIES:

• Monday: How much do we owe?
• Tuesday: Can we afford the rising cost of housing debt?
• Wednesday: High dairy price drives sharp fall in farm debt
• Thursday:
Banks need to do better on business lending
Consumer debt falling by billions but missed payments on the rise
• Friday: How problematic is NZ's pile of govt debt?